Modern forecast concepts for corporate management

An accurate and reliable forecast during the year is of great importance for companies to achieve their business goals, ensure their financial stability and improve their decision-making processes. Deviations from budget planning must be identified at an early stage so that proactive countermeasures can be taken. This is exactly what the forecast does.

8 success factors for your forecast

Forecast approach must fit the business model

But which forecast approach is the right one? Depending on the complexity and dynamics of their business model, companies need to decide what effort is required and what details need to be taken into account, and design the forecast accordingly. This blog article presents three modern forecast concepts with their strengths and weaknesses: the driver-based, the effects-based and the rolling forecast.

The list does not claim to be exhaustive. Nor is it a question of necessarily deciding in favor of just one forecast approach. Rather, the various concepts can be combined with each other in a meaningful way.

Driver-based forecast 

The focus of the driver-based forecast is on clearly defined, business-specific cause-effect relationships. The forecast is updated by forecasting the development of the key operational drivers in the cause-effect chain, such as sales volumes, raw material prices or selling prices.

We deliberately refrain from revising indirect costs to the nearest cost center, especially in the case of forecasts prepared at close intervals. Due to time and resource constraints, the revision of profit drivers is often performed centrally by controlling and management.

Benefits:

• High level of transparency regarding the generation of figures

• Excellent starting point for simulations and action-oriented controlling

• Efficient, fast forecast generation by focusing on the key drivers

Limitations:

• Model with partial validity, as only the key drivers are taken into account

• Support by suitable IT tools urgently required as complexity increases

• No or only little reference to budgets

Effects-based forecast

With the effects-based forecast, the starting point is not the actual, but the budget or the targets, even for the months that have already passed. Deviations from the budget that have already occurred or are expected to occur are only taken into account if no specific countermeasures can be taken.

A significant difference to the driver-based approach is that the evaluation of effects is not carried out by means of modeled calculation methods, but rather “in the head and gut” of management, so to speak. Instead of an exact determination, for example on the basis of driver trees, there is an assessment of (external) effects and (internal) measures that have an impact on the original target.

By virtually reversing the classic approach – planning the most realistic possible “to go” for the actual that can no longer be changed – the effects-based forecast promotes a cultural change in the company toward a stronger target achievement culture. It is also conceivable to use the effects-based forecast at group level as a complement to the conventional forecast.

Benefits:

• High efficiency through concentration on significant, known effects
• Immanent measure and thus control and decision orientation
• High degree of transparency
• Promotion of a culture of “achieving goals” instead of “signing off on goals”

Limitations:

• Defining effects and agreeing on which ones to consider can become complex if necessary
• Limited possibilities for automation, as effects and measures have to be recorded manually
• Approach is rather applicable only at high-level, as the system quickly becomes very complex

Rolling forecast

In contrast to the classic year-end forecast, the planning horizon for the rolling forecast in its original form always remains constant, for example by planning the next four quarters on a quarterly basis. This is pure “forward control”. Partially rolling forecasts are also conceivable with different horizons depending on when they are created in the fiscal year. Example: In Q2, planning is done until the end of the current fiscal year, from Q3 until the end of the following fiscal year.

The focus of the (partially) rolling forecast is on early warning and flexibility. This makes it an important management tool, especially in dynamic environments. In more static environments, the (partially) rolling forecast is of little use, since a relatively small amount of new knowledge is offset by a significant amount of effort.

Benefit:

• In dynamic environments, rolling forecasts provide plenty of time for relevant management impulses.
• “Forward control” instead of variance analyses
• Support for target setting for operational (budget) planning and strategic planning

Limitations:

• Negative cost/benefit ratio in rather static environments
• Rolling forecast does not replace the target-setting process or strategic planning

Combination of the different forecast concepts

Both driver-based and effects-based forecasting can be complemented with a rolling approach. Companies are thus “forced” to continuously look ahead. The view of the current fiscal year – often promoted by annual bonus systems – becomes less important.

However, combined approaches are very demanding concepts that quickly reach enormous complexity and therefore require a high level of IT support.

Conclusion: What is important in forecasting?

The forecast is an absolutely sensible management tool that helps companies to achieve the goals they originally set in their planning on the basis of new findings. In order for the forecast to fulfill its tasks, it is important to choose an approach that is suitable for the company. Among other things, the business model, the frequency of forecast creation, the relationship between effort and benefit, and the possibilities of IT support must be taken into consideration when selecting a concept.